The leap from investigating a franchise to buying one requires a reality check from any potential investor. Franchise loans are out there, but getting selected as a franchisee has different requirements. Funding is important, but it isn't the only step to financing your first location. There are three main components that will determine if you are financially solvent and solid enough to buy into the franchise you choose: your net worth, your liquid capital, and your credit history.
Determining if You Can Afford a Franchise
Net Worth
Before you commit to any franchise concept, you’ll need to know your documentable net worth. Every franchisor and every lender will have some measure of net worth they want you to meet as an assurance that you are financially solvent enough to successfully launch a new business.
To calculate your net worth, start with a summary of your assets, then subtract your liabilities. Don’t forget to include investment and retirement accounts, annuities, and any loans in your name.
If you have a very low or negative net worth number, you probably need to wait and beef up the asset side of your balance sheet (or reduce the debt side) before you move forward with franchise investment.
Most franchisors have a specific range of minimum net worth in mind for their franchisees, and that number is usually based on their experiences with successful (and sometimes unsuccessful) launches. They want to know you are financially sound enough to withstand the test of becoming a business owner.
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Liquid Capital
If your net worth is within the recommended range your franchise consultant or the franchise you have in mind suggest, your next step is assessing your liquid capital. This is the money you could, if you had to, produce in cash or easily convert to cash. Your liquid capital includes funds in savings accounts and accessible stock investments.
As a guideline, you can expect to need a minimum of $50,000 to $100,000 of available liquid capital for a service-based franchise concept and a minimum of $75,000 to $100,000 for a facility-based franchise. Depending on the size of the commitment you make with your franchise agreement—for instance in the case of a multiple territory development schedule or an exceptionally large and costly facility—you might need substantially more money at the table.
Keep in mind that these numbers only represent your liquid investment—not your total investment. Your total investment will include the liquid assets you commit to your project along with the financing you secure.
Your total available liquid capital may not all be sitting in a savings account or accessible at the ATM. If you don’t have sufficient liquid assets in savings to reach the investment threshold for your franchise of choice, you may have convertible assets that can add to your total. Home equity is one example.
If your home is worth more than you own on your mortgage, you may be able to access that value through a line of credit, thus converting it to a liquid asset. Retirement savings can also sometimes be leveraged to support your franchise investment through accounts that allow for self-directed investments.
The main point here is that if you have built up equity through your real estate or retirement investments, you may be able to tap that equity to create liquid capital. Doing so is a very personal decision and one that should not be taken lightly.
However you assemble the funds, your liquid capital serves two main purposes. The first is obvious: it helps pay for your initial investment, augmenting your loans and any other finance arrangements.
Second, your liquid capital represents your “skin in the game,” as the saying goes. When you put up as much as $100,000 of your own money to buy into a franchise concept, you demonstrate a tremendous personal commitment to the success of that investment. The franchisor wants you to be that committed, and so do the lenders who help you access the balance of your startup capital.
Credit History
Your credit history is a less tangible, but very important, part of your financial self-assessment. If you’ve made a habit of keeping your financial house in order, you’ll be rewarded when franchisors start looking at your suitability for their brand.
Franchisors may consider your credit rating, your proven financial stability, your tenure as an employee in various positions, and your payment histories when they weigh the risks of granting you a franchise. As part of your own due diligence, order a copy of your credit report and look for any inconsistencies or concerns. You’ll need to be prepared to explain any issues you find there.
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